Yedlin: Oilpatch results reflect improving environment

Oilpatch earnings season is almost over, and the announced results have been a marked improvement from a year earlier.

The fourth-quarter numbers, especially for oil-weighted producers, reflect higher oil prices seen in late 2017. Natural gas producers were at the opposite end of that story, however, with constrained pipeline access and a surfeit of supply keeping prices down.

Even the severe winter weather wasn’t enough to lift natural gas prices, which speaks to the fact the midstream segment of the industry has not kept pace with drilling volumes.

The winners in the natural gas game last year were companies that also had significant liquids production — which sells at, or close to, the price of West Texas Intermediate — a lower cost structure, strong balance sheets and access to transportation.

Companies with producing assets south of the border captured higher netbacks as a result of stronger pricing — and greater pipeline capacity.

The oil story saw crude average US$55.30 per barrel, with the spread between WTI and Western Canada Select narrower at $12.16. It was also a story of cost control, which most analysts believe has now played out the string, with little more to be realized on the cost side.

Improved profitability will need to come from increased production volumes — at the current cost structure — that leverage new technologies and processes.

The other piece — which the sector can’t control and would eliminate pricing challenges — is market access. There was no missing the sense of frustration on earnings calls over the lack of progress on what is an increasingly vexing problem.

Companies with minimal exposure to the discounted pricing are well-positioned for the first quarter of 2018, which has seen the differential widen to the $20 a barrel range.

Among the bigger surprises was the number of announced share buybacks — Suncor and Encana are two examples — and dividend increases, as with Canadian Natural Resources and Husky Energy. The fact companies were in a position to announce either action was a marked change from where the numbers stood in the fourth quarter of 2016.

This reflects balance sheets that have seen significant progress made in terms of debt reduction, which means capacity to take advantage of acquisition opportunities as companies reposition themselves by high-grading assets.

The stronger results of oil-weighted producers, however, is not about to translate into higher capital expenditure budgets. Besides the unresolved pipeline issues, another factor is the pace at which projects are waiting for approvals.

Suncor’s Mildred Lake extension, for example, filed for approval in 2014 and has yet to receive it. Similarly, Imperial Oil has been waiting for the green light on its Aspen project for at least 18 months.

It also bears mentioning the capital expenditure budgets unveiled late last year were clear from the perspective companies were in a position to grow production without piling on the big dollars. The take-away is that the industry is leveraging technology and new processes to increase productivity.

Another variable determining how much companies will spend is that the market is more interested in companies committing to capital discipline, whether in the context of share buybacks, dividend increases or paying down debt. U.S. producers were given a wake-up call by investors late last year. The message was to get balance sheets in order rather than continue to grow production at any cost.

Finally, there is the relative tax competitiveness of Canada versus the United States.

While this is mostly a moot point right now, as most companies are not currently cash taxable, said Mike Dunn of GMP FirstEnergy Capital Corp., the lower U.S. tax rate will factor into the investment decisions of companies able to invest south of the border — especially as they use their tax pools. Encana and Enerplus are just two examples.

Another important difference is the ability to write off investments. Under the new tax regulations, businesses can write off capital investments in the year they take place. That puts Canadian companies — energy sector included — at a disadvantage relative to those in the U.S.

The only offset now is the fact royalties are lower in Canada relative to the U.S., but that is unlikely to be enough to open the investment pipeline.

Not only is the drop in investment — expected to be 12 per cent this year — reflective of the uncertainty resident in the sector when it comes to everything from regulation to taxation and transportation infrastructure, that is never the whole story.

Commodity prices and interest rates play a role, too. Natural gas prices are not exactly on the upswing and interest rates are rising.

Peters & Co. is using a $1.51/mcf price forecast for natural gas this year. That would be the lowest annual average for the commodity since 1996.

All told, the fourth-quarter numbers have shown a different oilpatch than a year ago with balance sheets that are stronger and costs under control. That improvement is accompanied by a dose of pessimism due to the lack of progress on pipelines, the grim natural gas pricing outlook and regulatory uncertainty.

We talk a lot about how innovative Canada’s oilpatch can be — and has been — to be competitive. But it can’t do it alone.

If the fourth quarter of 2018 is to show improvement over last year, governments need to recognize they have a role to play. One that goes beyond talking and leads to outcomes that show concrete progress and certainty.